Trade Secrets Basics

Patrick M. Torre & Donovan Gibbs

This article was developed by the Kentucky Bar Association (KBA) Intellectual Property (IP) Section. To learn more about the KBA IP Section, visit https://www.kybar.org/page/intellectualproperty.

Patents, trademarks, and copyrights most immediately leap to mind when the topic of intellectual property (IP) is raised. However, an often overlooked type of IP, trade secrets, can be as, if not more, important to many business owners. As the name implies a trade secret is any information that provides a competitive edge and which derives its true economic value to a business from not being generally known by others. Trade secrets can include formulas/formulations, data, industrial processes, laboratory notebooks, technical know-how, blueprints, computer software that cannot lawfully be reverse engineered, training manuals, supplier identity, pricing/financial information, customer lists, and others.

Trade secrets provide no exclusivity to the owner. Unlike patents, trademarks, and copyrights, trade secrets maintain their value indefinitely when properly protected. Specific definitions of “trade secret” vary but the core requirements for a trade secret are information that is in fact a secret and derives actual or potential economic value to a business from that secrecy, and reasonable efforts made by the business to maintain that secrecy.

Others may discover a trade secret by fair means (independent discovery, permissible disclosure by another, reverse engineering, or other lawful means). Trade secret status provides protection only against misappropriation, i.e., improper acquisition and/or use of the information by others. Causes of action for trade secret misappropriation are available under a wide range of common law, state law, and federal law sources:

Common law tort/unfair competition

Prior the development of the Uniform Trade Secrets Act “UTSA”, improper use or disclosure of a trade secret was traditionally a common law tort. There are three fundamental elements to a trade secret tort claim. First, the subject matter involved must qualify for trade secret protection. U.S. courts widely adopted basic principles of trade secret law that were set forth in 757 and 758 of the Restatement of Torts (1939). In particular, § 757, comment b, listed six factors to be considered in determining whether information constitutes a trade secret: 1) The extent to which the information is known outside the claimant's business; 2) the extent to which it is known by employees and others involved in the business; 3) the extent of measures taken by the claimant to guard the secrecy of the information; 4) the value of the information to the business and its competitors; 5) the amount of effort or money expended by the business in developing the information; and, 6) the ease or difficulty with which the information could be properly acquired or duplicated by others.

Second, the holder of the subject matter must establish that reasonable precautions were taken to prevent disclosure of the subject matter, and lastly the trade secret holder must prove the information was misappropriated or wrongfully taken. Surprisingly, the use of a trade secret belonging to another does not always constitute misappropriation (as stated above, others may discover trade secrets by fair means). There are two basic situations in which obtaining the use of a trade secret is illegal; where it is acquired through improper means, or where it involves a breach of confidence.

Section 43 of the Restatement (Third) of Unfair Competition describes improper acquisition of trade secrets as; acquiring another’s trade secrets by fraud, theft, unauthorized interception of communications, inducement of or knowing participation in a breach of confidence, and other means wrongful in themselves. Further, under Section 41 of the same, it describes that a duty of confidence is owed by a person whom a trade secret has been disclosed if 1) an express promise of confidentiality was made prior to disclosure, or 2) the person knew or had reason to know the disclosure was intended to be in confidence, and the disclosing party was reasonable in inferring that the person consented to an obligation of confidentiality.

If appropriate, under Section 44 injunctive relief may be awarded to prevent a continuing or threatened appropriation of another’s trade secret (injunctive relief is a court order commanding or preventing an action.) Also, if appropriate, a trade secret owner may be entitled to monetary relief for the misappropriation of the trade secret. Under Section 45 one who is liable to another for an appropriation of the other’s trade secret is liable for pecuniary loss to the other caused by the appropriation or for the actor’s own pecuniary gain resulting from the appropriation.

Uniform Trade Secrets Act (UTSA) of 1985

Forty-eight states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands have enacted some version of the UTSA, with state-to-state distinctions that require careful consideration. State courts generally have jurisdiction over UTSA claims but standalone UTSA claims can be filed in federal court if diversity jurisdiction requirements are met. Civil remedies for trade secret misappropriation under the UTSA include injunctive relief, payment of reasonable royalties for continued future use, and monetary damages such as plaintiff’s lost profits and costs to enforce potentially including attorney’s fees, defendant’s unjust enrichment and profits resulting from the misappropriation, and punitive damages in appropriate circumstances.

Economic Espionage Act (EEA) of 1996 (18 U.S.C. §1831)

The EEA is primarily directed to industrial espionage, is the first federal law criminalizing trade secret misappropriation, and imposes criminal sanctions relating to theft or misappropriation of trade secrets. One provision of this legislation criminalizes misappropriation of trade secrets with the knowledge or intent that the theft would benefit a foreign power (economic espionage), providing for imposing fines (up to $5,000,000) and prison sentences of up to 15 years. Another provision of the EEA imposes criminal penalties for the misappropriation of trade secrets related to or included in a product that is produced for or placed in interstate or international commerce with the knowledge that the misappropriation would injure the owner of the trade secret (commercial theft), and provides for fines (up to $250,000) and prison sentences of up to 10 years.

Section 337 of the Tariff Act of 1930

Section 337 of the Tariff Act of 1930 (19 U.S.C. §1337) provides a mechanism for trade secret owners to file trade secret misappropriation claims at the U.S. International Trade Commission (ITC). The statute prohibits unfair trade/unfair competition in importation and sale of imported articles. The ITC is authorized to issue Exclusion Orders to stop importation of products that harm U.S. industry and are made using misappropriated trade secrets. Relief can be granted even if acts of misappropriation take place outside the U.S. Monetary damages are not provided for.

Defend Trade Secrets Act (DTSA) of 2016 (18 USC §1836 et seq.)

The DTSA is a more recent civil cause of action that allows uniform nationwide application in Federal court to address trade secret misappropriation. DTSA standing exists only where the trade secret is “related to a product or service used in, or intended for use in, interstate or foreign commerce (18 U.S.C. §1836(b)(1)). The DTSA does not replace the UTSA or preempt state law, but provides a parallel right for filing trade secret misappropriation lawsuits in federal court if “the trade secret is related to a product or service used in … interstate or foreign commerce” (18 U.S.C. §1836(c)). A three-year statute of limitations tolls from the date on which the misappropriation was, or by the exercise of reasonable diligence should have been, discovered (18 U.S.C. §1836(d)).

Misappropriation under the DTSA requires wrongful acquisition of a trade secret and also wrongful use or disclosure of a trade secret. This is the acquisition of a trade secret by a person who knows or has reason to know that the acquisition was made by improper means, followed by the use or disclosure of the trade secret by one who: (1) used improper means to acquire the secret; or (2) knew or had reason to know that the secret was: (a) derived from a person who used improper means to acquire it; (b) acquired under circumstances giving rise to a duty to maintain its secrecy; or (c) derived from or through a person who owed a duty to the owner to maintain its secrecy (18 U.S.C. §§1839(5)(A), 1839(5)(B)).

Many key definitions of the DTSA are derived from the UTSA, with some important differences. “Improper means” under DTSA includes “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means (18 U.S.C. §§1839(6)(A)). Lawful means of acquisition such as reverse engineering, independent derivation, and others are expressly excluded from the definition of “improper means” (18 U.S.C. §1839(6)(B)). An “owner” of a trade secret under the DTSA includes the legal owner, an equitable title holder, and a licensee of the trade secret owner (18 U.S.C. §1839(4)).

The DTSA includes provisions to protect confidentiality of trade secrets that are the subject of a DTSA proceeding. The DTSA also provides immunization from liability under federal and state law for certain disclosures of trade secret information (18 U.S.C. §1833(b)(1)(A)), including: disclosures made in confidence to a federal, state, or local government official, or to an attorney solely for the purpose of reporting or investigating suspected violations of law (whistleblower safe harbor); disclosures made in a complaint or other document filed under seal in a lawsuit or other proceeding; and disclosures to an attorney or in a court proceeding by an individual who files a lawsuit alleging employer retaliation for reporting a suspected violation of law, as long as court filings are under seal and the individual does not otherwise disclose a trade secret except pursuant to a court order.

There are also key provisions in DTSA relating to employees. Employers are required to provide notice of the DTSA’s immunity from disclosure provisions in any contract or agreement with an “employee” (traditional employees, independent contractors, and consultants (18 U.S.C. §1833(b)(1)(A))) relating to use of trade secrets or other confidential information. Alternatively, the employer can in a nondisclosure agreement reference a policy document provided to employees and setting forth a formal reporting policy for suspected violations of law (18 U.S.C. §1833(b)(1)(B)). The DTSA notice requirements apply only to contracts/agreements entered into after May 11, 2016 (18 U.S.C. §1833(b)(1)(D)).

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Civil remedies available under the DTSA are similar to those of the UTSA. However, the DTSA limits injunctive relief available to employers. An injunction preventing an employee from entering into an employment relationship must be based on evidence of threatened misappropriation, not merely on information that the person possesses. The DTSA bars injunctive relief that would otherwise conflict with state law prohibiting restraints on the practice of a lawful profession, trade, or business. Ex parte civil seizures of property are available under DTSA when necessary to prevent the dissemination of a misappropriated trade secret (18 U.S.C. §1836(b)(2) et seq.), but only in “extraordinary circumstances” such as a defendant expected to attempt to flee the country or not otherwise subject to enforcement of a U.S. court’s order.

Many businesses are unaware of the broad scope of information, in-house procedures, etc. that can and should be protected as trade secrets and fail to take the needed steps to protect their rights. Equally, businesses should clearly establish the importance of trade secrets to new and prospective employees. In addition to including proper notice of trade secret confidentiality provisions in employment agreements, business owners should be diligent in reminding soon-to-be former employees of their duty to maintain trade secret confidentiality in exit interviews, and in requiring such employees to sign Employee Separation Agreements or Termination Statements listing business information known to the employee to be trade secrets and acknowledging the employee’s obligation to maintain the proprietary nature of the trade secrets.

A careful review by a law firm familiar with trade secret law and practice to identify a business’s trade secrets and the procedures put in place to preserve trade secret confidentiality is a great investment in the business’s future!